Can An OPEC Deal Save Venezuelan Oil From Total Collapse?

At times it seems that Venezuela’s economic crisis cannot get any worse. Food shortages, electricity blackouts, and scarce medical supplies have created a humanitarian disaster in Venezuela. However, with each passing month the situation deteriorates, and the crisis appears to be entering a dangerous new phase.

Venezuela’s currency has lost about 45 percent of its value so far in November, the worst monthly decline on record. Inflation is thought to be hovering at around 400 percent, according to Bloomberg, although some analysts put it as high as 1,500 percent. “Inflation is going to keep rising, there’s a risk of default, and the political situation is becoming more tense each day. People prefer to protect their money,” Asdrubal Oliveros, director of Caracas-based economic consultancy Ecoanalitica, told Bloomberg.

The horrific humanitarian crisis is only deepening, with food shortages becoming so acute that Venezuelans are starting to flee in large numbers, heading to Colombia, or Brazil, or even setting sail on small boats to seek food, shelter and work on some Caribbean islands. This could yet turn into a major refugee crisis. Venezuela is dangerously short on medical supplies, and the conditions in the country’s hospitals are some of the worst in the world outside of Syria.

The government of Venezuelan President Nicolas Maduro is hoping it will soon get some relief. China has decided to invest $2.2 billion into Venezuela’s decrepit oil sector, in exchange for a larger share of the country’s output. By some estimates, China has dumped $65 billion into Venezuela over the past decade, making the South American country too big to fail for Beijing. Venezuela has been paying that toll back in oil, earmarking some 550,000 barrels per day in output for China. But the latest deal will bring that obligation up to 800,000 barrels per day.

Venezuela needs the investment to repair crumbling energy infrastructure, which is leading to steady declines in oil production. Venezuela’s refineries are also in a sorry state. An explosion recently engulfed a PDVSA refinery. Also, Reuters reports that the country’s refining network is operating at just a third of capacity.

So the Chinese investment is welcome, but it also means that it will have less oil left over for sale. At this point, the government of Nicolas Maduro has little choice. For selfish reasons, China is trying to keep Venezuela’s oil sector from total collapse. “The imperative is to ensure no disruption of oil flow,” said Mei Xinyu, a senior researcher with China’s Ministry of Commerce, according to Bloomberg. “The political situation takes a back seat to the importance of oil production. Even if the opposition party takes power in the future, they’ll still need Chinese loans to pump out oil.” And while China has often been a friend to Venezuela in a time of need, even China’s confidence in its South American ally is wearing thin. Bloomberg reported that the state-owned China National Petroleum Corp. is cutting non-oil investments in Venezuela, noting an “unstable investment climate” and a “growing default risk.”

Maduro has also made an all-out effort to convince fellow OPEC members to agree to cut production at the upcoming meeting in Vienna. He’s confident that a deal is within reach, although one might say that he is simply putting on a brave face because OPEC is the only hope he has left. Oil analysts see oil rising to at least $55 per barrel if OPEC agrees to cut output, according to a Wall Street Journal survey of a dozen investment banks. The flip side is that crude prices could fall back to $40 if OPEC fails. At the time of this writing, Saudi Arabia had backed out of a meeting with non-OPEC members scheduled for Nov. 28 because Saudi

Needless to say, Venezuela’s immediate future could get a lot worse if the Vienna talks fall apart. The state-owned PDVSA recently missed a bond payment, which started the clock on a 30-day grace period before the company is in default. The Venezuelan government has been careful over the years to meet all its debt obligations in order to stay in good stead with the bond markets, so the late interest payment is a bad sign about the deteriorating finances of the state. JP Morgan still believes PDVSA will make the payment, and the deal that Venezuela made with creditors a few weeks ago to extend repayment terms provided a bit of breathing room. But the government’s cash reserves are down to a rather meager $10 billion.

While the short-term crisis is acute, there aren’t a lot of reasons to be any more confident about the longer-term. There are still very decent odds of a major debt default at some point, which will only make the crisis worse, if that is possible. Venezuela is a “failing state,” as The New Yorker put it recently. The country has already lost roughly 300,000 barrels per day this year. More losses could be coming.